Protecting Your Money in the Market

I would like to take some time out today to talk to everybody about investing. Not so much about how to make money, but instead on how to protect money. When I talk about protecting money, there is one man that comes to mind in particular. During last fall, when the markets began to really crash, he came up to me and told me about the great losses he's had in his retirement account. I asked them one simple question, and instead of giving me a verbal answer he just lowered his head in shame. Now I did not ask this question to embarrass him, but instead to educate him.

Ever since then I have always kept my eye out for people who do not protect their money. And let me tell you every day I run into more and more people who do not take measures to protect their own money. Today I'm going to talk about two strategies you can use in the stock market to protect your money. These are not new strategies, they have been around for very long time. However, people still look past them as if they actually know what they're doing.

The first one I'm willing to talk about is called a stop limit order or just a stop order. First and foremost let me say this and let me be clear, I'm not giving you investment advice. I am simply pointing out what already exists and what you may want to educate yourself about. I'm not telling you what to do, I'm just pointing out what you may want to look into. I know what I'm saying is confusing, so let me just put it simple: if you lose money it's not my fault.

Now then let me get to the meat and potatoes of the subject. The first thing you need to do in executing a stop order is to make sure your brokerage will support. I've worked with brokers before that don't do things like advance orders and this is something you probably should steer away from. Not that these brokers are bad or I'm trying to say that they're bad, but there's just some things your broker should be doing for you automatically like advance orders. So first before you try to do anything check with your broker and make sure you're able to do advanced orders.

So by now you should already have check with your broker and made sure everything is good to go. A stop order is so easy you're probably going to laugh if you've never heard of it before but yet people don't utilize it and end up losing more money than they have to. So let's paint a picture here. Let's say you just put an order in and you thought it was going to go in one direction and for example say you bought XYZ stock at $50 share. So the market opened, you put your trade in, and you went off to work. So you're having a great day at work when you glanced over at the television. It just so happened be one of those fine finance channels that we have all across the television network. And you notice that they just flashed XYZ stock. Well guess what, it drop down significantly to the $35 a share. And as a seat of your pants fills up with a foul-smelling material, you soon realize that you have absolutely no access to a computer at work. And as you sit there in your own fecal matter, you begin to feel so bad for yourself as you see XYZ dropped from 35 to 30.

Now if you're active trader asked yourself how many times have you been in a situation. I think I've made my point why you'd want to utilize the stop order. A stop order is simply an order that you place with your broker which is good till canceled, where you tell your broker to sell a certain stock when it is at or below a certain price. So in this situation that we just described, right after you bought XYZ at $50 share, you could have immediately told your broker to sell XYZ if it drop below $30 or $35 a share. With this would have done is instead of you crapping your pants at work, you would still crap your pants but know that you had some sort of protection from losing all your money.

Some people would say you should always use a stop order no matter what. But there are certain situations which a stop work actually hurt you and not help you. Let's say instead of buying XYZ $50 share that morning, you place the order the day before. And when the market opened up the next day, the stock gaps from $50 share down to $20. If you had a stop order you would have been pulled out of the position right when the market opened. Obviously this would not be a good situation especially if the stock shot right back up to $50 within the first hour. But never fear there's another trick we could use.

This next trick I'm talking about involves using options. Specifically we will be talking about using a protective put option. Now if you're unfamiliar with options I recommend you to become familiar very fast, because they're a very powerful thing you could use in the stockmarket. So real quick were going to go over options and then talk specifically about the protective put option. The basic definition of an option is this: An option is a contract between the buyer and seller which gives the buyer the right, not the obligation, to either buy or sell a tangible item at a specific price, within a specific timeframe".

So in the stock market, if you wanted to buy a call option on XYZ stock, and we are in January, you could buy an option to buy XYZ stock at $50 a share that would last you until May. What this basically says is that you have the right to buy the stock at $50 a share between now and May no matter what the stock price does. If the stock goes up to $1 million a share, you still get the buy it for $50. The only time where this does not apply is if you let the option expire past May. This is called a call option. A put option is exactly the opposite, in which it gives you the right to sell at a specific price. For instance, let's say you owned 100 shares of XYZ stock, and you bought it at $50 a share, you can buy a put option that gives you the right to sell XYZ stock at $50 a share. When you do this, you give yourself the right to sell your stock if it ever goes below $50 a share. If the stock goes all the way down to zero, you can still sell at $50. Utilizing a put option like this is called a protective put, and I hope you can see how powerful this could be.

So one more time, a stop order is a good till canceled order with your broker which instructs them to sell a stock when it is at or below a set price that you indicate. A protective put is a strategy you use where you purchase put options on the stock you already own. This acts like an insurance policy on your stock, where no matter what happens to your stock, if it gaps or just falls all the way down to zero in one day a protective put strategy will still protect your money. Using protective puts have two problems: one, it costs money and two, options expire so you would have to renew this every time the protective put option expired.

No matter what the downfalls are of using these protective strategies, I will say that there are far more worth having in my trading arsenal then ignoring him and losing all my money. Now I may not be the best person in picking stocks, but I can tell you right now I have saved more money than I could imagine by using these two things. If you have any questions about using these two strategies I suggest you call your broker and ask them; they should be the best people to tell you. Above all keep educating yourself, and I will talk to you later.

Until next time,
John